Giddy in the Spin Cycle
News about the San Fernando Valley’s real estate market these days is either really good or really bad--depending on where you stand. If you’re on the front lawn of your own house, recent price jumps most certainly sound like good news. But if you’re driving around with a real estate agent looking to buy a first home, the 11.7% leap in median home prices over the past year seems like bad news that threatens to lock buyers with moderate incomes out of the market. As Valley real estate continues to post strong gains for the first time in nearly a decade, it’s worth noting that the recent strength is part of a long-term cycle of boom and bust that produces both winners and losers--and alternately widens or narrows the gap between rich and poor.
Between March 1997 and March 1998, median home sale prices jumped from $145,900 to $163,000. Although not as accurate a predictor of actual costs, the average sales price jumped a whopping 27.6% from $181,800 to $232,000. Over the same period, the number of closed escrows increased 23.1% from 1,149 to 1,414 and the number of active listings fell 20.8% from 6,320 to 5,008. Any amateur economist can draw the graph: Prices should continue to rise as long as the quantity demanded exceeds the quantity supplied. Indeed, real estate agents are trying to explain the recent swelling in prices with traditional economic theories such as pent-up demand, low interest rates and a healthy economy.
Of course those factors play a role. But they do not completely explain the current giddiness in the real estate market as homes are snatched up before they go on the market and bidders drive prices well above what’s asked. During the last real estate boom--in the late 1980s--economists Karl E. Case and Robert J. Schiller sought to explain the behavior of buyers and their research remains relevant in the current climate. Case and Schiller found that although most home buyers consider the purchase an investment, very few understand the risks. In fact, nearly two-thirds of the Southern California home buyers polled by Case and Schiller during the last boom considered their purchase virtually risk-free. The crash of 1991 and the 1994 Northridge earthquake revealed how wrong they were. Even today, average Valley home prices are 15% below what they were in 1990.
Case and Schiller suggested then, and it remains true today, that most buyers approach the biggest purchase of their lives with something less than purely rational expectations--a tendency that increases during the pressure of a boom when optimism reigns and buyers fear getting locked out as the market heats up further. Plus, a boom accrues more wealth to those who already have it and puts renters even further from home ownership. So while the recent boost to home prices is a testament to the faith residents have in the local economy and in their own futures, it’s wise not to get too caught up in the excitement. Who knows what tomorrow holds?
